Neil Woodford believes we are in bubble territory, which has created an opportunity he has only seen a handful of times in his career.
'Ten years on from the global financial crisis, we are witnessing the product of the biggest monetary policy experiment in history. Investors have forgotten about risk and this is playing out in inflated asset prices and inflated valuations,' Woodford said.
'Whether it’s Bitcoin going through $10,000, European junk bonds yielding less than US Treasuries, historic low levels of volatility or triple- leveraged ETFs attracting gigantic inflows – there are so many lights flashing red that I am losing count.'
Woodford said stock valuations had increasingly concerned him over the last couple of years, with the difference between the performance of value and growth stocks greater than at any stage in stock market history.
He drew attention to the chart below to underline just how 'drastic' the situation has become.
'What we see here is the stretch away from trend, between the performance of US value stocks and US growth stocks. It tells you all you need to know about current market conditions across the globe,' Woodford said.
'We’ve had our fair share of bubbles in this period, as highlighted on the chart. The Wall Street Crash looks like a tiny blip compared to some of the other periods of market madness that we have seen, when fundamentals become irrelevant and animal spirits take over temporarily as the primary driver of share prices.'
Woodford is currently enduring one of the most difficult periods in his fund management career following a number of well-publicised stock problems, including Capita and Provident Financial.
His flagship Woodford Income fund is near the bottom of its peer group over one year, returning just 2% versus the peer group average of 11.5%.
While at Invesco Perpetual, Woodford famously stayed clear of tech stocks during the dotcom bubble in the nineties and he draws comparisons between then and now.
'Obviously, the late nineties dotcom bubble was a painful period of performance for me – its impact on valuation stretch is all to visibly acute on the chart but, in the context of history, it was a brief dislocation,' Woodford said.
'[But] By focusing resolutely on fundamentals, my funds enjoyed a meaningful period of positive performance when the bubble burst, continuing to rise in value as the market plummeted in 2000 and 2001.'
Woodford pointed out that during the dotcom bubble it was old economy stocks that were hit, while today it is domestically-focused stocks which have become profoundly unloved and undervalued.
'The funds I manage are positioned to exploit this opportunity and I am utterly convinced it will pay-off when the bubble bursts, which I believe it inevitably will,' he said.
While there are echoes of the tech bubble today, he feels the current climate is perhaps more akin to the 'nifty-fifty bubble' which afflicted stock markets in the late 1960s and early 1970s.
'A narrow group of so-called “one-decision” stocks with dependable growth characteristics enjoyed a run of popularity with investors that took their valuations to extreme, unsustainable levels,' Woodford said.
'In a challenging global economic environment, the few stocks that are perceived to be capable of delivering dependable growth have, like in the early-1970s, become very popular but that popularity has manifested itself in extreme and unsustainable valuations.'
He added: 'A consistent feature of bubbles is that here is always a subset of the market which falls out of favour as investors clamour for the fashionable stocks of the day, providing the fuel to power the bubble on through the final leg of its journey before it bursts.'
Woodford accepts timing of such an event is not easy, but notes there are certain events on the horizon that could prompt the market to acknowledge that some parts of the global growth outlook are nowhere near as benign as it has complacently believed.
'Investors should be careful chasing the zeitgeist. The temptations and excesses are right here, right now.
'There is always risk when markets become obsessed and extreme but there is also opportunity – an opportunity to capture assets at incredibly depressed valuations, the likes of which I have only seen two or three times during my 30-year career.'